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EMERGING MARKETS DEBT. Knight Capital - June 30 th 2011. Alfredo Viegas 203-930-7180. Low ($975 or less) Lower middle ($976 - $3,855) Upper middle ($3,856 - $11,905). No Data High ($11,906 or more). Emerging Markets Debt – Geography What is an “Emerging Market Country?”.
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EMERGING MARKETS DEBT Knight Capital - June 30th 2011 Alfredo Viegas 203-930-7180
Low ($975 or less) Lower middle ($976 - $3,855) Upper middle ($3,856 - $11,905) No Data High ($11,906 or more) Emerging Markets Debt – GeographyWhat is an “Emerging Market Country?” World GNI per capita No ‘hard’ definition or rule World Bank definition: a country with a gross national income per head between $975 and $11,905* 50 countries in the broader benchmarks** GNI Per Capita 2008* Source: * World Bank, as of June 2010 ** S&P Investable and S&P Frontier benchmarks combined 2
Emerging Markets Debt – Present day…Emerging Markets are important… Emerging Markets already important Source: BofA Merrill Lynch Global Equity Strategy, BP, CIA World Factbook, IMF World Economic Outlook, MSCI, as of June 2010 3
Emerging Markets Debt – History and FutureTimes change and Economies Rise and Fall… • Once upon a time… • We may take the current world environment as status quo… but that is a mistake. Economies Rise & Fall • Global economic leadership is expected to look very different in 40 years… 4
Emerging Markets Debt – Why Invest?Too Important to ignore… Too important to ignore (84% of world’s population, 23% of world’s GNI)* Strong growth relative to developed economies Diversification advantages Premium returns achieved as economies emerge Economic / market developments reduce risk of crises 5
Emerging Markets Debt – Why Invest?That’s where the growth is! Hong Kong/Singapore G7 Taiwan Israel S. Korea Maturity Czech/Hungary/Poland Mexico Malaysia Brazil Egypt Russia China Sub-Saharan Africa India Frontier markets deregulation Emerging markets Premium growth (5%-7%) Established growth (3%-5%) Mature economies (2%-3%) Time Emerging economies characterized by strong economic growth Source: Schroders as of December 2009 Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell. 6
Emerging Markets Debt – Why Invest?Emerging Market Economies have had extraordinary growth… Cumulative change in USD GDP, 2000-2010E (%) Emerging Markets Frontiers Developed GDP growth has come from Emerging and Frontiers markets not Developed Source: UBS estimates, IMF, Haver, CEIC. Data as of January 2011 Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The data includes some forecasted views. We believe that we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. There is no guarantee that any forecasts or opinions will be realized. 7
Emerging Markets Debt – Growth to continue?This is the chart that should really scare you… Hourly Labor Costs in US$, 2010 Low labor costs Source: EIU estimates, as of June 2010 Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell. 8
Emerging Markets Debt – Growth to continue?The growth should start shifting to internal consumption… 2011(F) contribution to real GDP growth for major emerging markets % Emerging Markets growth expected to continue to be internally driven Source: JP Morgan, Economics Team estimates, as of October 2010 The data includes some forecasted views. We believe that we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. There is no guarantee that any forecasts or opinions will be realized. Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell. 9
Emerging Markets Debt – Growth to continue?The growth should start shifting to internal consumption… BRIC - Household Disposable Income over US$10,000 (Millions) BRICs consumer has become a driving force in the global economy Source: Euromonitor, Morgan Stanley Research. As of December 2010 The data includes some forecasted views. We believe that we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. There is no guarantee that any forecasts or opinions will be realized. Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell. 10
Emerging Markets Debt – Growth to continue?The growth should start shifting to internal consumption… Monthly motor vehicle sales (millions) Penetration rate / consumption per capita, China as % of world average Emerging consumers more important than developed consumers GDP per capita (PPP): China = 57% of world Avg. 11
Socialization of Private Debts is an uncertain strategy… Sovereign Policy is fully in “experimental stage” -- we think this suggests Sovereign UNDERPERFORMANCE Emerging Markets Debt – EM’s got their sh!t togetherMedium term: core imbalances remain and policy responses remain unorthodox Political Imperative remains to ‘kick the can’ to the next guy… 12
Emerging Markets Debt – 2011 EM a safe haven…This Time it IS Different – Deficits, Unsustainable Debt & Demographics Advanced and Emerging Economies: Cyclically Adjusted Primary Balance (CAPB), Primary Balance (PB), and Government Debt, 2007–14 (In percent of GDP) Source: IMF • Advanced economies face large primary deficits even adjusting for the cycle • Debt and deficit problems are centered in the advanced economies • Primary balances (ex interest expense) are forecasted to remain negative and continue to increase debt accumulation
Emerging Markets Debt – Fiscal sanityEmerging Market Countries do not have the debt hangover problem… Private and public sector debt/GDP% of GDP Emerging economies generally have very low levels of debt Source: ING. Data to December 2009 Countries mentioned are shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. 14
Emerging Markets Debt – Fiscal sanityHouseholds in Emerging Markets also hold much less debt… Household debt as a % of GDP Mature Markets85.6% Emerging Asia32.4% Emerging Europe28.8% Latin America13.4% Emerging economies never took on debt the way developed markets did Source: Morgan Stanley as of April 2010 Data to December 2009. Countries mentioned are shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. 15
Emerging Markets Debt – 2011 an inflection year?This Time it IS Different – Difficult Demographics % of Population over 65 EU-27 Dependency Ratio is worrisome… • Population demographics in the G-7 are very unfavorable, distinctly different from post WW2 when demographic trends were positive • The number of people 65 or older will increase by 90% by 2035, to 20% of the population • By 2060 the problem in developed economies, such as the EU-27 will be particularly worrisome… 16
Emerging Markets Debt – Demographics & Resources Unlike the Developed world… Resources and demographics Percentage of population over retirement age % World’s total % Long term prospects are favorable to Emerging Markets Source: CSIS and World Economic Outlook The opinions stated in this presentation include some forecasted views. We believe that we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee that any forecasts or opinions will be realized. 17
Emerging Markets Debt – 2011 G-7 debt spiral?This Time it IS Different – Destructive Debt Dynamics… General Government Net Debt Scenario Under 2010 Policies (In percent of GDP) These figures DO NOT INCLUDE entitlements! Source: IMF • Unprecedented adjustments are required across the G-7 • The status quo is not an option • Under current and future pressures on public finances public debt would spiral out of control in the absence of meaningful fiscal adjustment
Emerging Markets Debt – The Equities storyThis has become rather well known by now… Emerging Markets weighting in MSCI All Country World Index ( ~ $40 Trillion) Emerging Markets’ weighting has increased significantly over recent years – over $7 Trillion 19 Source: MSCI Barra Research. Data to December 31, 2010
Emerging Markets Debt – The Equities storyBut it is still by no means finished growing… Global stock markets1 Global economy (Share of GDP)2 Ratio of market capitalization to GDP3 Capitalization/GDP (Dec 09) UK Australia Canada US Japan Germany Emerging Markets (49% by 2011 and 59% by 2030)² (19% by 2011 and 31% by 2030)² GDP Per capita (09) Emerging Market stock markets under-represented relative to size of economies 1Source: Factset, MSCI, data shown for December 2009 using MSCI World and MSCI EM indices (MSCI AC World) 2Source: Goldman Sachs, Global Economics Paper No:204 as of September 2010 3Source: IMF, Factset, MSCI, data shown for 2009 Countries are mentioned for illustrative purposes only and should not be viewed as a recommendation to buy/sell. 20
Emerging Markets Debt – The Equities storyNevertheless… it has had a good run over the past 10 years. MSCI Emerging Markets Index Performance 2001-2010 Annual Returns Net (TR) US$ Performance (Net US$) % Outperformed in 9 out of the last 10 years Source: Factset, Performance Net TR (US$), as of December 2010 Performance shown is past performance. Past performance is not necessarily a guide to future performance. The value of investment can go down as well as up and is not guaranteed. 21
Emerging Markets External Debt – 2010 Record Year • WALL OF MONEY… IFC says $825Bn in 2010… 2011 to exceed $1T ? • EM Equity in the 5th inning… EM Debt in the 2nd inning ?Global EM equity allocation = 6% - according to GS => 18% which means $4TEM Debt allocation <2% - PIMCO suggests should be over 20% => over $6T according to EPFR in 2010 >$40Bn inflow in US EM bond funds alone… • Record SUPPLY in 2010 likely to be matched in 2011…454 deals in 2010 through end November, $610mn avg size for $279B in supply Corporate deals => Majority of supply 385 or 85% of supply or $201B 22
Emerging Markets Debt – Knight FocusWe participate primarily in the EXTERNAL DEBT segment Growth in local market issuance Total universe by sector EXTERNAL DEBT 15% Corporate Debt 9% Govt. Debt 6% US$ billion Corporate Debt 31% Govt. Debt 54% LOCAL DEBT 85% Emerging Market Debt TOTAL over US$9 trillion Source: Merrill Lynch – December 2010 23
Emerging Markets Debt – Knight FocusExternal Debt – What, How and Why… 1990 – Brady Plan --- the start of the asset class $170Bn issued ($148Bn Latam) Today 42 countries, over $9 Trillion market with only 6.5% of original Brady bonds left EM External Debt Segment is $1.5 Trillion - US High Grade is $2.2 Trillion - US High Yield is $500 Bn Other products include local bonds, rates, FX and capital markets. Economic / market developments reduce risk of crises 24
Emerging Markets Debt – 2011 how to positionWe Prefer to own Corporate Issuers in 2011 & Avoid selective sovereigns… • A Barbell Approach to Uncertainties… 1) UNDERWEIGHT SOVEREIGNS • Sovereign ‘ceiling’ pierced definitively in Euroland… a “Berlin Wall Moment” ? • Sovereign credit quality already much improved – now over 60% investment grade… what’s left?!? 25
Emerging Markets Debt – 2011 how to positionWe Prefer to own Corporate Issuers in 2011 & Avoid selective sovereigns… • Underweight Sovereigns with “GAP Risk” and high debt ratios • Investor memories are short-term -- the next global crisis is likely to trigger the same SELLS across the board… 26
Emerging Markets Debt – 2011 how to positionWe Prefer to own Corporate Issuers in 2011 • EM Corporates used to trade through sovereigns… & they outperform… • Within the EM Corporate Universe focus in on EVENTS & Special Situations… • Focus on the alpha… where the space is not yet crowded… • Since 2005 there has been over $1.7T issued in EM corporate Eurobonds, with over 1,000 distinct issuers… • Majority of EM fixed income assets and specialistsare focused on sovereign issuers 27
Second Half 2011 – Timing, Trends and Threats…EM Fixed Income: External Spreads Dynamics… Flows & Composition • Correlation of Private FDI Flows with EMBI spread is 0.73 • Over 60% of EMBI now Investment Grade… meaning increased UST risk • Out of Index positioning key factors: Corporates: 10 – 25% Mostly BB or better (Rate Risk) Single “B” – Esoteric Sovereigns • EMBI+ ↑3.2% EMBIG ↑3.7% Vene + Mex Contributers Turkey + Argie Laggerds Source: IIF, Bloomberg; Knight Research 28
Emerging Markets Debt – 2011 how to positionWe Prefer to own Corporate Issuers in 2011 • A Barbell Approach to Uncertainties… 2) OVERWEIGHT EM Corporates • Corporate Balance sheets are stronger, have greater transparency & SHOULD TRADE THROUGH SOVEREIGNS • CS Indices: EMCI (EM Corporate Bond) SBI (EM Sovereign Bond Index) & LUCI (US Liquid High-grade Index) • Average quality of EMCI is “BBB/BBB+” while SBI average quality is “BBB-/BBB” & LUCI is about “A-” • Consequently, we see scope here for EMCI to tighten over 50bp THROUGH SBI Index. • YTD EMCI z-spreads are unchanged at +316bp while SBI z-spreads are wider by about 8bp to +267bp. Historical tights for SBI spreads were z+175bp & for EMCI were z+275bp. Hence, we continue to see scope for outperformance 29
Emerging Markets Debt – How Knight Makes $We are an agency broker. • PRINCIPAL MODEL • Trade for yourself • Conflicts of Interest • Utilize and motivatestaff to prioritize Firm over Client • BROKERAGE • Traditional Agency • Principal INVESTMENT BANKCapital MarketsConsulting/AdvisoryASSET MANAGERAsset ManagementCustody + = The Traditional Agency Model • CLIENT MODEL • Pure Agency(Bonfire analogy) • Mitigate Market Impact • Provide Value-AddedResearch and Ideas • Independent • Variable Cost • Low Margin/ Low Risk Universal Investment Bank 30
Question: What would you advise your client to do with $10mn? Greece 30 year bondGGB 4.6 @ $43 – YTM 11% 5 Year Chinese Corporate IssuerInitially rated “BB” & 6.25% couponNow trading at 50 with fraud allegations 1 2 10 Year Kazakhstan Nat’l Oil Co.KZOKZ 7 @ 110 -- YTM 5.5% Venezuela 30 year bondVENZ 7 @ 58 -- YTM 12.4% 4 3 a) Hedge Fund b) Insurance Account c) Distressed Investor d) EM Mutual Fund 33